AUDIT PLANNING

DEFINITION
According to AAS-8, Audit planning refers to planning by the auditor made to enable him to conduct an effective audit, in an efficient and timely manner, and includes planning about area, scope, depth of transactions to be audited, persons to be deployed for audit etc.,. Audit planning is the process of deciding in advance what is to be done, who is to do it, how it is to be done, and when it is to be done by the auditor in order to have an effective and efficient completion of audit.

OVERVIEW OF THE AUDIT PROCESS

The overall objective of the financial statement audit is the expression of an opinion on whether the clients financial statements are presented fairly, in all material respects, in conformity with GAAP. The diagnostic process of making judgments about the accounts likely to contain material misstatement and obtaining evidence about fair presentation in the financial statements involves a number of steps.

1. Knowledge of the Business and Industry:

The auditor should obtain sufficient knowledge and understanding of the clients business and industry to understand the events, transactions, and practices that may have a significant effect on the financial statements. Developing expectations of financial statements involves using knowledge of business performance to develop an expectation of the amounts reported in the financial statements. When an entity makes extensive use of electronic data interchange, the auditor might decide to increase the level of audit personnel with computer specialization.

Evaluation of reasonableness of accounting estimates involves that many critical aspects of financial statements, such as the valuation of the allowance for doubtful accounts, or the inventory obsolescence, or warranty reserves, often involve significant professional judgment. There are many key aspects GAAP that are industry specific. Many industries (such as Agricultural producers and cooperatives, to casinos, Health care organizations, or Investment companies. Several members of an audit team usually have significant experience in an industry and understand the resources and core processes that are needed to compete effectively in the industry.

2. Managements Assertions:
Financial statements include both explicit and implicit assertions and are important as they guide the auditor in the collection of evidence Auditing Standards Board has recognized the five broad categories of financial statement assertions. They are:

a.Existence or Occurrence: It deals with whether assets or liabilities of the entity exist at a given date and whether recorded transactions have occurred during a given period. b.Completeness: It deals with whether all transactions and account that should be presented in the financial statements are indeed included.

c.Rights and Obligations: It deals with whether assets are the rights of the entity and liabilities are the obligations of the entity at a given date. d.Valuation or Allocation: It deals with whether asset, liability, revenue, and expense components have been included in the financial statements at appropriate amounts (i.e., in conformity with GAAP and is clerically and mathematically accurate). e.Presentation and Disclosure: It deals with whether particular components of the financial statements are properly classified, described, and disclosed.

3. Materiality:

FASB Concepts Statement No.2 defines materiality as the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influence by the omission or misstatement. The auditor makes a judgment about materiality while planning the engagement in order to make important decisions about the scope of the audit Materiality is an important concept that guides the auditor in setting the scope of audit work to find omission or misstatements that would potentially aggregate to an amount that would influence financial statement users.

The concept of materiality guides the auditor when evaluating audit findings. Once auditors collect audit evidence, they must assess the significance of audit findings.

4. Audit Risk:
Since the audit does not guarantee that the financial statements are free of material misstatement, some degree of risk exists that the financial statements may contain misstatements that go undetected by the auditor. SAS-47 (AU 312.02) defines as Audit risk is the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that contain a material misstatement.

If the auditor interprets reasonable assurance as a 99% level of certainty that the financial statements are free of material misstatement, then the audit risk is 1%, whereas if 95% certainty is considered satisfactory, then audit risk is 5%. The ultimate challenge of the audit is that auditors cannot examine all possible evidence regarding every assertion for every account balance and transaction class.

Audit Risk Components: As a practical matter the auditor must consider audit risk not only for each account balance and transaction class, but for each assertion relevant to material account balances or transaction classes.

a.Inherent Risk: It is the susceptibility of an assertion to a material misstatement, assuming that there are no related internal controls. The assessment of inherent risk involves evaluating factors that may cause misstatements in an assertion. Example: Valuations requiring complex calculations are more likely to be misstated than simple calculations. b.Control Risk: It is the risk that a material misstatement that could occur in an assertion will not be prevented or detected on a timely basis by the entitys internal controls. Todays business environment usually relies on computerized internal controls.

It is important for auditors to have a good understanding of the design and operation of computer controls as well as how technology may be used to test the effectiveness of computer controls.

c.Detection Risk: Detection risk is the risk that the auditor will not detect a material misstatement that exists in an assertion. Once the auditor has made decisions about overall audit risk, inherent risk, and control risk, he or she uses the audit risk model to guide decisions about the audit evidence that is needed to restrict detection risk to an appropriately low level. The auditor controls detection risk by using professional judgment to make decisions about which audit procedures to perform, when to perform audit procedures, the extensiveness of audit procedures, and who should perform audit procedures.

Audit Risk Model:

The concept of audit risk is consistent with the fact that the audit is designed to provide reasonable assurance, not absolute assurance, that the financial statements are free of material misstatements. The audit does not guarantee that the financial statements are free of material misstatement.

The audit risk model may be expressed quantitatively as follows: AR = IRCRDR The symbols represent audit, inherent, control, and detection risk respectively.

To illustrate the use of the model, assume that the auditor made the following professional judgments for a particular assertion, such as the valuation or allocation assertion for accounts receivable: AR=5%, IR=90%, and CR=20% Detection risk can be determined by solving the model for DR as follows: DR = (AR) / (IRCR) = .05 / (.9.2) =.28 or 28%

5. Evidence: Sufficient competent evidential matter is to be obtained through inspection, observations, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit. The standard specifies that sufficient (enough) competent (reliable) evidential matter should be obtained to provide a reasonable (rational) basis for an opinion on the financial statements. The collection and evaluation of audit evidence is at the core of the audit. In general, more evidence is needed for accounts that are material to the financial statements than for accounts that are immaterial.

An auditor works within economic limits that dictate that significant evidence must be obtained within a reasonable time and at a reasonable cost. The size of the accounting populations underlying many financial statement items make sampling a necessity in gathering evidence. Generally, a larger the population, the larger the quantity of evidence required to obtain a reasonable basis for reaching a conclusion about it. The reliability of the accounting records is directly related to the effectiveness of the clients internal controls. The competency of confirming information depends on many factors such as; relevance, source, timeliness, and objectivity.

Classification of Audit Procedures: An auditor performs audit procedures to obtain evidence to support an opinion on the financial statements. They are: a.Procedures to obtain an understanding: In performing the audit, an auditor usually performs procedures to obtain an understanding of the client, its business and industry, and factors that may affect the inherent risk of misstatement in an assertion. b.Tests of Controls: They are made to provide evidence about the effectiveness of the design and operation of internal control structure policies and procedures. Example: A computer control procedure uses batch totals to ensure that the entire batch of transactions is recorded. c. Substantive Tests: They provide evidence as to the fairness of managements financial statement assertions.

Substantive tests consists of: a. Analytical procedures involve the use of comparisons to assess fairness. Example: Sale per square foot of retail price. b. Tests of details of transactions involve examining support for the individual transactions posted to an account. Example: Vouching debits to accounts receivable to entries in the sales journal and supporting sales invoices. c. Tests of details of balances involve examining support for the ending balance directly. Example: Confirming an ending accounts receivable balance directly with the customers.

6. Consideration of Value-Added Services: In order to effectively audit the financial statements of a company the CPA must be able to: Apply ethical rules of the profession Understand an entitys goals and objectives and determine the degree to which those goals and objectives have been met Understand the companys internal controls and evaluate the degree to which they serve the clients needs Assess risk, verify managements assertions, and document audit conclusions Evaluate an entitys cash flow, profitability, liquidity, solvency, and operating cycle and its performance in an industry relate to its competitors

7. Communication of Findings: The final key element of the audit involves communication of findings. The audit, and other services performed as part of the audit, are of no value until they are communicated to management and others who use the audit. The communication of audit findings can be divided into three categories, they are: a. The Auditors report on financial statements b. Other required communications such as internal controls, significant accounting policies, management judgments, significant audit judgments, disagreements with management, consultation with other accountants, difficulties encountered in performing the audit etc., c. Communication of other findings such as value-added services, describing the scope of work performed, the findings and conclusions.